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Pre-Halloween Scare

Over the last month the markets took a turn for the worse. The S&P 500 has been down 4.5%, the Nasdaq has shed 6.8% and the S&P TSX has lost 8%. It seems like the markets have been spooked by the approach of Halloween. The critics and doubters of the stock market are out again making their rounds. Your relatives are no doubt telling you to get out of the “casino” before the “house” takes all your money. Oh how we have such short term memories. Just a few months ago we were all rejoicing record highs and double digit gains for the year. Now it just seems like a distant memory. People who might have started investing have probably been scared off and sold off for losses and vow never to return to stocks. This is how the emotional investor thinks about investing. It’s not about the future, it’s about the now.

Year To Date

A look back to what the markets have done for the year and we can see that the S&P 500 is still up 3%, the Nasdaq is still up 2.4% and the S&P TSX is still up 4.45%. These are not bad numbers and still don’t include dividend payments. On paper, the markets have still outstripped GICs and CDAs. But why do we panic and make quick judgements? It’s the whole recency effect that most people have. Add that to the negative media that gets thrown in our faces and we start to making irrational judgements. Also remember that it wouldn’t be uncommon for 2014 to end as a down year after the average growth of the markets has been over 10% over the past 5. As I had written before in my year end review of 2013, the expectation is that the markets wouldn’t be able to continue this torrent upward movement. It just isn’t sustainable. This is a race for the tortoise, not the hare.

Long Term Outlook

Short term performance of the markets should not be the indicator of whether or not we should continue investing. The key is keeping your own personal investment portfolio balanced to match your risk profile. When it comes to investing, one should really be looking at the long term trends. How well has the market done in the last 10 years, 15, years or maybe even 25 years. The goal isn’t to time the market and buy at the market’s absolute low. That is impossible to predict. The horizon for any investment portfolio should be long term. Ask the questions: What has the market done for me in the last 10 years? What will it do for me in the next 10 years? Most people will read this and find it absurd. They want results and they want it now. They want their BMW now. They want their house now. They want to be a millionaire now. The unfortunate fact of life is that nothing happens in the blink of an eye. Building wealth through your investments takes patience and time.

The Perfect Balance

There is a reason why this blog and many other financial sites tell you not to keep all your money tied to one type of asset. Even if it means giving up the potential for larger gains. The extreme volatility that the stock markets have seen hasn’t been reflected wit the bond market. Bonds have remained resilient and have become this year’s best performer. The two graphs below show two popular Canadian Couch Potato bond ETFs.

Despite the large dips that the markets have experienced, the two bonds funds have held up. That’s generally because bonds have a negative correlation to the stock market. The high quality government bond fund has maintained a 4.2% gain year-to-date, while the real return bonds have increased a whopping 11.87% year-to-date. This doesn’t include the interest of 3% and 2% that each of these funds return back to investors on an annual basis. Bonds will always provide the stability in any portfolio to mitigate the risks of investing in the stock market. Finding the right balance between bonds, stocks, cash and real estate is entirely up to the risk tolerance of the individual investor. Don’t ever discount what other asset types can do to help you build your own personal portfolio.

Taking Action

With the wild fluctuations of the markets, it’s actually a good point in time to see if your portfolio still remains in balance. Are you now overweight in bonds versus your stocks. It’s a perfect chance to do a rebalancing of your portfolio if you haven’t done so. Remember that the idea is to keep the allocation of your funds in the same ratio that you originally set based on your risk tolerance. If you are stuck on figuring out how to balance your portfolio, remember to check out my previous post on how to do it.